The system and method described below relate, in general, to automated, electronic trading of Financial Instruments and, more particularly, to a system and method for operating an on-demand auction in Financial Instruments.
In recent years, financial markets have evolved from largely manual processing of orders to fully automated, electronic processing of orders by computers. The automation has frequently been accompanied by reduced visible liquidity resulting in increased difficulty and increased cost in executing large orders. Frequently this is the result of intermediation by third parties which, in part, results from market fragmentation.
Historically, liquidity providers could manually interact with large orders without exposing those orders publicly. This historical process permitted a pool of liquidity to be gathered to help execute a large order with minimal information leakage.
Today, these liquidity providers and the manual approach to executing large orders have largely been replaced by automated liquidity providers who typically provide only a small amount of liquidity at a given price point and various algorithmic approaches to filling large orders by slicing them into minute pieces which seek to trade against today's liquidity providers in the small size typically available at any given time. These changes have complicated the ability to execute a transaction of large size.
Large orders sliced into many, many small orders by sophisticated algorithms can lead to information leakage. Other sophisticated algorithms—scanning for information leakage—detect large orders, step ahead of them, and often take on positions as intermediaries. When an intermediary steps ahead of a large order, the result is an adverse price movement for the large order. If the intermediary eventually provides liquidity for the large order, this process will have made it more expensive to complete the large order.
This has further been exacerbated by ever-faster response times by markets and some Market Participants. Shortened time frames make it difficult for many potential liquidity providers to react to a large order. This limits the pool of liquidity providers who are able to compete in today's environment. Reduced competition results in higher execution costs for large orders.
To address these problems, the marketplace needs a method for large natural buyers or sellers to attract significant liquidity pools with little to no information leakage—at least prior to the transaction. The new method must balance the conflict between giving potential liquidity providers sufficient time to react to the need for liquidity and minimizing interference with open trading which typically has response times measured in microseconds.